12 March 2009
[Federal Register: March 12, 2009 (Volume 74, Number 47)]
[Notices]
[Page 10791-10800]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12mr09-115]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-59527; File No. S7-05-09]
Order Granting Temporary Exemptions Under the Securities Exchange
Act of 1934 in Connection With Request on Behalf of ICE U.S. Trust LLC
Related to Central Clearing of Credit Default Swaps, and Request for
Comments
March 6, 2009.
I. Introduction
In response to the recent turmoil in the financial markets, the
Securities and Exchange Commission (``Commission'') has taken multiple
actions to protect investors and ensure the integrity of the nation's
securities markets.\1\ Today the Commission is taking further action
designed to address concerns related to the market in credit default
swaps (``CDS''). The over-the-counter (``OTC'') market for CDS has been
a source of concerns to us and other financial regulators. These
concerns include the systemic risk posed by CDS, highlighted by the
possible inability of parties to meet their obligations as
counterparties and the potential resulting adverse effects on other
markets and the financial system.\2\ Recent credit market events have
demonstrated the seriousness of these risks in a CDS market operating
without meaningful regulation, transparency,\3\ or central
counterparties (``CCPs'').\4\ These events have emphasized the need for
CCPs as mechanisms to help control such risks.\5\ A CCP for CDS could
be an important step in reducing the counterparty risks inherent in the
CDS market, and thereby help mitigate potential systemic impacts. In
November 2008, the President's Working Group on Financial Markets
stated that the implementation of a CCP for CDS was a top priority \6\
and, in furtherance of this recommendation, the Commission, the FRB and
the Commodity Futures Trading Commission (``CFTC'') signed a Memorandum
of Understanding \7\ that establishes a framework for consultation and
information sharing on issues related to CCPs for CDS. Given the
continued uncertainty in this market, taking action to help foster the
prompt development of CCPs, including granting conditional exemptions
from certain provisions of the Federal securities laws, is in the
public interest.
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\1\ A nonexclusive list of the Commission's actions to stabilize
financial markets during this credit crisis include: adopting a
package of measures to strengthen investor protections against naked
short selling, including rules requiring a hard T+3 close-out,
eliminating the options market maker exception of Regulation SHO,
and expressly targeting fraud in short selling transactions (See
Securities Exchange Act Release No. 58572 (September 17, 2008), 73
FR 54875 (September 23, 2008)); issuing an emergency order to
enhance protections against naked short selling in the securities of
primary dealers, Federal National Mortgage Association (``Fannie
Mae''), and Federal Home Loan Mortgage Corporation (``Freddie Mac'')
(See Securities Exchange Act Release No. 58166 (July 15, 2008), 73
FR 42379 (July 21, 2008)); taking temporary emergency action to ban
short selling in financial securities (See Securities Exchange Act
Release No. 58592 (September 18, 2008), 73 FR 55169 (September 24,
2008)); approving emergency rulemaking to ensure disclosure of short
positions by hedge funds and other institutional money managers (See
Securities Exchange Act Release No. 58591A (September 21, 2008), 73
FR 55557 (September 25, 2008)); proposing rules to strengthen the
regulation of credit rating agencies and making the limits and
purposes of credit ratings clearer to investors (See Securities
Exchange Act Release No. 57967 (June 16, 2008), 73 FR 36212 (June
25, 2008); entering into a Memorandum of Understanding with the
Board of Governors of the Federal Reserve System (``FRB'') to make
sure key Federal financial regulators share information and
coordinate regulatory activities in important areas of common
interest (See Memorandum of Understanding Between the U.S.
Securities and Exchange Commission and the Board of Governors of the
Federal Reserve System Regarding Coordination and Information
Sharing in Areas of Common Regulatory and Supervisory Interest (July
7, 2008), http://www.sec.gov/news/press/2008/2008-134_mou.pdf).
\2\ In addition to the potential systemic risks that CDS pose to
financial stability, we are concerned about other potential risks in
this market, including operational risks, risks relating to
manipulation and fraud, and regulatory arbitrage risks.
\3\ See Policy Objectives for the OTC Derivatives Market, The
President's Working Group on Financial Markets, November 14, 2008,
available at http://www.ustreas.gov/press/releases/reports/
policyobjectives.pdf (``Public reporting of prices, trading volumes
and aggregate open interest should be required to increase market
transparency for participants and the public.'').
\4\ See The Role of Credit Derivatives in the U.S. Economy
Before the H. Agric. Comm., 110th Cong. (2008) (Statement of Erik
Sirri, Director of the Division of Trading and Markets, Commission).
\5\ See id.
\6\ See Policy Objectives for the OTC Derivatives Market, The
President's Working Group on Financial Markets (November 14, 2008),
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf.
See also Policy Statement on Financial Market Developments, The
President's Working Group on Financial Markets (March 13, 2008),
http://www.treas.gov/press/releases/reports/
pwgpolicystatemktturmoil_03122008.pdf; Progress Update on March
Policy Statement on Financial Market Developments, The President's
Working Group on Financial Markets (October 2008), http://
www.treas.gov/press/releases/reports/q4progress%20update.pdf.
\7\ See Memorandum of Understanding Between the Board of
Governors of the Federal Reserve System, the U.S. Commodity Futures
Trading Commission and the U.S. Securities and Exchange Commission
Regarding Central Counterparties for Credit Default Swaps (November
14, 2008), http://www.treas.gov/press/releases/reports/finalmou.pdf.
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A CDS is a bilateral contract between two parties, known as
counterparties. The value of this financial contract is based on
underlying obligations of a single entity or on a particular security
or other debt obligation, or an index of several such entities,
securities, or obligations. The obligation of a seller under a CDS to
make payments under a CDS contract is triggered by a default or other
credit event as to such entity or entities or such security or
securities. Investors may use CDS for a variety of reasons, including
to offset or insure against risk in their fixed-income portfolios, to
take positions in bonds or in segments of the debt market as
represented by an index, or to capitalize on the volatility in credit
spreads during times of economic uncertainty. In recent years, CDS
market volumes have rapidly increased.\8\ This growth has coincided
with a significant rise in the types and number of entities
participating in the CDS market.\9\
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\8\ See Semiannual OTC derivatives statistics at end-December
2007, Bank for International Settlements (``BIS''), available at
http://www.bis.org/statistics/otcder/dt1920a.pdf.
\9\ CDS were initially created to meet the demand of banking
institutions looking to hedge and diversify the credit risk
attendant with their lending activities. However, financial
institutions such as insurance companies, pension funds, securities
firms, and hedge funds have entered the CDS market.
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The Commission's authority over this OTC market for CDS is limited.
Specifically, Section 3A of the Securities Exchange Act of 1934
(``Exchange Act'') limits the Commission's authority over swap
agreements, as defined in Section 206A of the Gramm-Leach-Bliley
Act.\10\ For
[[Page 10792]]
those CDS that are swap agreements, the exclusion from the definition
of security in Section 3A of the Exchange Act, and related provisions,
will continue to apply. The Commission's action today does not affect
these CDS, and this Order does not apply to them. For those CDS that
are not swap agreements (``non-excluded CDS''), the Commission's action
today provides conditional exemptions from certain requirements of the
Exchange Act.
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\10\ 15 U.S.C. 78c-1. Section 3A excludes both a non-security-
based and a security-based swap agreement from the definition of
``security'' under Section 3(a)(10) of the Exchange Act, 15 U.S.C.
78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a
``swap agreement'' as ``any agreement, contract, or transaction
between eligible contract participants (as defined in section 1a(12)
of the Commodity Exchange Act * * *) * * * the material terms of
which (other than price and quantity) are subject to individual
negotiation.'' 15 U.S.C. 78c note.
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The Commission believes that using well-regulated CCPs to clear
transactions in CDS would help promote efficiency and reduce risk in
the CDS market and among its participants. These benefits could be
particularly significant in times of market stress, as CCPs would
mitigate the potential for a market participant's failure to
destabilize other market participants, and reduce the effects of
misinformation and rumors. CCP-maintained records of CDS transactions
would also aid the Commission's efforts to prevent and detect fraud and
other abusive market practices.
A well-regulated CCP also would address concerns about counterparty
risk by substituting the creditworthiness and liquidity of the CCP for
the creditworthiness and liquidity of the counterparties to a CDS. In
the absence of a CCP, participants in the OTC CDS market must carefully
manage their counterparty risks because the default by a counterparty
can render worthless, and payment delay can reduce the usefulness of,
the credit protection that has been bought by a CDS purchaser. CDS
participants currently attempt to manage counterparty risk by carefully
selecting and monitoring their counterparties, entering into legal
agreements that permit them to net gains and losses across contracts
with a defaulting counterparty, and often requiring counterparty
exposures to be collateralized.\11\ A CCP could allow participants to
avoid these risks specific to individual counterparties because a CCP
``novates'' bilateral trades by entering into separate contractual
arrangements with both counterparties--becoming buyer to one and seller
to the other.\12\ Through novation, it is the CCP that assumes
counterparty risks.
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\11\ See generally R. Bliss and C. Papathanassiou, ``Derivatives
clearing, central counterparties and novation: The economic
implications'' (March 8, 2006), at 6. See also ``New Developments in
Clearing and Settlement Arrangements for OTC Derivatives,''
Committee on Payment and Settlement Systems, BIS, at 25 (March
2007), available at http://www.bis.org/pub/cpss77.pdf; ``Reducing
Risks and Improving Oversight in the OTC Credit Derivatives
Market,'' Before the Sen. Subcomm. On Secs., Ins. and Investments,
110th Cong. (2008) (Statement of Patrick Parkinson, Deputy Director,
Division of Research and Statistics, FRB).
\12\ ``Novation'' is a ``process through which the original
obligation between a buyer and seller is discharged through the
substitution of the CCP as seller to buyer and buyer to seller,
creating two new contracts.'' Committee on Payment and Settlement
Systems, Technical Committee of the International Organization of
Securities Commissioners, Recommendations for Central Counterparties
(November 2004) at 66.
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For this reason, a CCP for CDS would contribute generally to the
goal of market stability. As part of its risk management, a CCP may
subject novated contracts to initial and variation margin requirements
and establish a clearing fund. The CCP also may implement a loss-
sharing arrangement among its participants to respond to a participant
insolvency or default.
A CCP would also reduce CDS risks through multilateral netting of
trades.\13\ Trades cleared through a CCP would permit market
participants to accept the best bid or offer from a dealer in the OTC
market with very brief exposure to the creditworthiness of the dealer.
In addition, by allowing netting of positions in similar instruments,
and netting of gains and losses across different instruments, a CCP
would reduce redundant notional exposures and promote the more
efficient use of resources for monitoring and managing CDS positions.
Through uniform margining and other risk controls, including controls
on market-wide concentrations that cannot be implemented effectively
when counterparty risk management is decentralized, a CCP can help
prevent a single market participant's failure from destabilizing other
market participants and, ultimately, the broader financial system.
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\13\ See ``New Developments in Clearing and Settlement
Arrangements for OTC Derivatives,'' supra note 11, at 25.
Multilateral netting of trades would permit multiple counterparties
to offset their open transaction exposure through the CCP, spreading
credit risk across all participants in the clearing system and more
effectively diffusing the risk of a counterparty's default than
could be accomplished by bilateral netting alone.
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In this context, IntercontinentalExchange, Inc. (``ICE'') and The
Clearing Corporation (``TCC''), on behalf of ICE U.S. Trust LLC (``ICE
Trust''), have requested that the Commission grant exemptions from
certain requirements under the Exchange Act with respect to the
proposed activities of ICE Trust in clearing and settling certain CDS,
as well as the proposed activities of certain other persons, as
described below.\14\
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\14\ See Letter from Johnathan Short, InterContinental Exchange,
Inc. and Kevin McClear, The Clearing Corporation, to Elizabeth
Murphy, Secretary, Commission, February 26, 2009.
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Based on the facts presented and the representations made in the
request on behalf of ICE Trust,\15\ and for the reasons discussed in
this Order, the Commission temporarily is exempting, subject to certain
conditions, ICE Trust from the requirement to register as a clearing
agency under Section 17A of the Exchange Act solely to perform the
functions of a clearing agency for certain non-excluded CDS
transactions. The Commission also temporarily is exempting eligible
contract participants and others from certain Exchange Act requirements
with respect to non-excluded CDS cleared by ICE Trust. In addition, the
Commission temporarily is exempting ICE Trust and certain participants
of ICE Trust from the registration requirements of Sections 5 and 6 of
the Exchange Act solely in connection with the calculation of mark-to-
market prices for non-excluded CDS cleared by ICE Trust. The
Commission's exemptions are temporary and will expire on December 7,
2009. To facilitate the operation of one or more CCPs for the CDS
market, the Commission has also approved interim final temporary rules
providing exemptions under the Securities Act of 1933 and the Exchange
Act for non-excluded CDS.\16\ Finally, the Commission has provided
temporary exemptions in connection with Sections 5 and 6 of the
Exchange Act for transactions in non-excluded CDS.\17\
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\15\ See id. The exemptions we are granting today are based on
representations made in the request on behalf of ICE Trust. We
recognize, however, that there could be legal uncertainty in the
event that one or more of the underlying representations were to
become inaccurate. Accordingly, if any of these exemptions were to
become unavailable by reason of an underlying representation no
longer being materially accurate, the legal status of existing open
positions in non-excluded CDS associated with persons subject to
those unavailable exemptions would remain unchanged, but no new
positions could be established pursuant to the exemptions until all
of the underlying representations were again accurate.
\16\ See Securities Act Release No. 33-8999 (January 14, 2009).
\17\ See Securities Exchange Act Release No. 59165 (December 24,
2008).
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II. Discussion
A. Description of ICE Trust's Proposal
The exemptive request on behalf of ICE Trust describes how the
proposed arrangements for central clearing of CDS by ICE Trust would
operate, and makes representations about the safeguards associated with
those arrangements, as described below:
[[Page 10793]]
1. ICE Trust Organization
ICE Trust is organized as a New York State chartered limited
liability trust company and has received approval of its application to
become a member of the Federal Reserve System. ICE Trust is subject to
direct supervision and examination by the New York State Banking
Department (``NYSBD''), and, in association with the approval of its
application to become a member of the Federal Reserve System, will be
subject to direct supervision and examination by the FRB, specifically
the Federal Reserve Bank of New York.
2. ICE Trust Central Counterparty Services for CDS
Initially, ICE Trust's business will be limited to the provision of
clearing services for the OTC CDS market. ICE Trust will act as a
central counterparty for ICE Trust Participants (as defined below) \18\
by assuming, through novation, the obligations of all eligible CDS
transactions accepted by it for clearing and collecting margin and
other credit support from ICE Trust Participants to collateralize their
obligations to ICE Trust. ICE Trust's trade submission process is
designed to ensure that it maintains a matched book of offsetting CDS
contracts.
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\18\ See note 35, infra.
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Although CDS are currently bilaterally negotiated and executed,
major market participants frequently use the Deriv/SERV service of The
Depository Trust & Clearing Corporation (``DTCC'') comparison and
confirmation service when documenting their CDS transactions. This
service creates electronic records of transaction terms and
counterparties. As part of this service, market participants separately
submit the terms of a CDS transaction to Deriv/SERV in electronic form.
Paired submissions are compared to verify that their terms match in all
required respects. If a match is confirmed, the parties receive an
electronic confirmation of the submitted transaction. All submitted
transactions are recorded in the Deriv/SERV Trade Information
Warehouse, which serves as the primary registry for submitted
transactions.
ICE Trust will leverage the Deriv/SERV infrastructure in operating
its CDS clearing service. Initially, all trades submitted by
Participants for clearing through ICE Trust will be recorded in the
Deriv/SERV Trade Information Warehouse. ICE Trust will, initially on a
weekly basis, obtain from DTCC matched trades that have been recorded
in the Deriv/SERV Trade Information Warehouse as having been submitted
for clearing through ICE Trust. Within two months of launch, ICE Trust
intends to obtain matched trades from DTCC on a daily basis.
Participants may use the facilities of an inter-dealer broker to
execute CDS transactions, for example, to access liquidity more rapidly
or to maintain pre-execution anonymity and submit such transactions for
clearance and settlement to ICE Trust. The inter-dealer brokers do not
assume market positions in connection with their intermediation of CDS
transactions.
Once a matched CDS contract has been forwarded to, or obtained by,
ICE Trust, and has been accepted for clearing by it, ICE Trust will
clear the CDS contract by becoming the central counterparty to each
party to the trade through novation. Deriv/SERV's current
infrastructure will help to ensure that ICE Trust maintains a matched
book of offsetting CDS contracts. Maintaining a matched offsetting book
is essential to managing the credit risk associated with CDS submitted
to ICE Trust for clearing.
Under the ICE Trust's current draft rules (``ICE Trust Rules''),
each bilateral CDS contract between two ICE Trust Participants that is
submitted, and accepted by ICE Trust, for clearing will be ``novated.''
As part of this process, each bilateral CDS contract submitted to ICE
Trust will be replaced by two superseding CDS contracts between each of
the original parties to the submitted transaction and ICE Trust. Under
these new contracts, ICE Trust will act as the counterparty to each of
the original parties. As central counterparty to each novated CDS
contract, ICE Trust will be able to net offsetting positions on a
multilateral basis, even though ICE Trust will have different
counterparties with respect to the novated CDS contracts that are being
netted.
As part of the novation process, the terms and conditions governing
the CDS bilaterally negotiated by the submitting counterparties will be
superseded by the relevant provisions of the ICE Trust Rules applicable
to the relevant CDS transaction. Multilateral netting will
significantly reduce the outstanding notional amount of each ICE Trust
Participant's CDS portfolio. When ICE Trust acts as the central
counterparty to all cleared CDS of an ICE Trust Participant, that
participant's positions will be netted down to a single exposure to ICE
Trust.
3. ICE Trust Risk Management
ICE Trust will mitigate counterparty risk through its margin,
guaranty fund, and credit support framework, as set forth in the ICE
Trust Rules. ICE Trust's risk management infrastructure and related
risk metrics will be structured specifically for the CDS products that
ICE Trust clears. Each ICE Trust Participant's credit support
obligations will be governed by a uniform credit support framework and
applicable ICE Trust Rules.
ICE Trust represents that it will maintain strict, objectively
determined, risk-based margin and guaranty fund requirements, which
will be subject to extensive and ongoing regulation and oversight by
the FRB and the NYSBD. These requirements will also be consistent with
clearing industry practice, Basel II capital adequacy standards, and
international standards established for central counterparties as
articulated in the Bank for International Settlements / International
Organization of Securities Commissions (``IOSCO'') CCP Recommendations.
The amount of margin and guaranty fund required of each ICE Trust
Participant will be continuously adjusted to reflect the size and
profile of, and risk associated with, the ICE Trust Participant's
cleared CDS transactions (and related market factors).
Pursuant to ICE Trust Rules, each ICE Trust Participant's margin
requirement will consist of two components: (1) Initial margin,
reflecting a risk-based calculation of potential loss on outstanding
CDS positions in the event of a significant adverse market movement,
and (2) mark-to-market margin, based upon an end-of-day mark-to-market
of outstanding positions. Acceptable margin will initially include only
cash in specified currencies and G-7 government debt for initial margin
and only cash for mark-to-market margin. ICE Trust Participants will be
required to cover any end-of-day margin deficit with U.S. dollars by
the following morning, and ICE Trust will have the discretion to
require and collect additional margin, both at the end of the day and
intraday, as it deems necessary.\19\
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\19\ An ICE Trust Participant would be permitted to withdraw
mark-to-market margin amounts credited to its account to the extent
not required to satisfy its initial margin requirement.
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ICE Trust will also maintain a guaranty fund (the ``Guaranty
Fund'') to cover losses arising from an ICE Trust Participant's default
on cleared CDS transactions that exceed the amount of margin held by
ICE Trust from the defaulting ICE Trust Participant. Each ICE Trust
Participant will be required to contribute a minimum of $20 million to
the Guaranty Fund initially when it becomes an ICE Trust Participant
and
[[Page 10794]]
on an ongoing basis, additional amounts based on its actual and
anticipated CDS position exposures. The adequacy of the Guaranty Fund
will be monitored daily and the need for additional contributions will
be determined on at least a monthly basis, based on the size of ICE
Trust Participant exposures within the ICE Trust clearing system. As a
result, the Guaranty Fund will grow in proportion to the position risk
associated with the aggregate volume of CDS cleared by ICE Trust.
ICE Trust will also establish rules that ``mutualize'' the risk of
an ICE Trust Participant default across all ICE Trust Participants. In
the event of an ICE Trust Participant's default, ICE Trust may look to
the margin posted by such participant, such participant's Guaranty Fund
contributions and, if applicable, any recovery from a parent guarantor.
In addition, at its discretion, ICE Trust will be authorized to use, to
the extent needed, other ICE Trust Participants' Guaranty Fund
contributions to satisfy any obligations of the defaulting ICE Trust
Participant; provided that, any recovery from the defaulting ICE Trust
Participant, its parent guarantor, if any, or the sale of the
defaulting ICE Trust Participant's positions in ICE Trust will first be
used to refund any amounts utilized by ICE Trust from contributions of
non-defaulting ICE Trust Participants to the Guaranty Fund.
4. Member Default
Following a default by an ICE Trust Participant, ICE Trust has a
number of tools available to it under the ICE Trust Rules to ensure an
orderly liquidation and unwinding of the open positions of such
defaulting ICE Trust Participant. In the first instance, upon
determining that a default has occurred, ICE Trust will have the
ability to immediately enter into replacement CDS transactions with
other ICE Trust Participants that are designed to mitigate, to the
greatest extent possible, the market risk of the defaulting ICE Trust
Participant's open positions. For open positions in which there is no
liquid trading market, ICE Trust may enter into covering CDS
transactions for which there is a liquid market and that are most
closely correlated with such illiquid open positions.
After entering into covering transactions in the open market, if
any, ICE Trust will seek to close out any remaining open positions of
the defaulting ICE Trust Participant (including any initial covering
transactions) by using one or more auctions or other commercially
reasonable unwind processes. The ICE Trust Rules will prohibit ICE
Trust from entering into any replacement transaction if the price of
such transaction would be below the least favorable price that would be
reasonable to accept for such replacement transaction. To the extent
ICE Trust is not able to enter into the necessary replacement
transactions through auctions or open market processes, ICE Trust will
be entitled to allocate such replacement transactions to the remaining
ICE Trust Participants at the floor price established by ICE Trust.
B. Temporary Conditional Exemptions From Clearing Agency and Exchange
Registration Requirements
1. Exemption From Section 17A of the Exchange Act
Section 17A of the Exchange Act sets forth the framework for the
regulation and operation of the U.S. clearance and settlement system,
including CCPs. Specifically, Section 17A directs the Commission to use
its authority to promote enumerated Congressional objectives and to
facilitate the development of a national clearance and settlement
system for securities transactions. Absent an exemption, a CCP that
novates trades of non-excluded CDS that are securities and generates
money and settlement obligations for participants is required to
register with the Commission as a clearing agency.
Section 36 of the Exchange Act authorizes the Commission to
conditionally or unconditionally exempt any person, security, or
transaction, or any class or classes of persons, securities, or
transactions, from any provision or provisions of the Exchange Act or
any rule or regulation thereunder, by rule, regulation, or order, to
the extent that such exemption is necessary or appropriate in the
public interest, and is consistent with the protection of
investors.\20\
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\20\ 15 U.S.C. 78mm.
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Accordingly, pursuant to Section 36 of the Exchange Act, the
Commission finds that it is necessary or appropriate in the public
interest and is consistent with the protection of investors to exercise
its authority to grant an exemption until December 7, 2009 to ICE Trust
from Section 17A of the Exchange Act, solely to perform the functions
of a clearing agency for Cleared CDS,\21\ subject to the conditions
discussed below.
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\21\ For purposes of this exemption, and the other exemptions
addressed in this Order, ``Cleared CDS'' means a credit default swap
that is submitted (or offered, purchased, or sold on terms providing
for submission) to ICE Trust, that is offered only to, purchased
only by, and sold only to eligible contract participants (as defined
in Section 1a(12) of the Commodity Exchange Act as in effect on the
date of this Order (other than a person that is an eligible contract
participant under paragraph (C) of that section)), and in which: (i)
The reference entity, the issuer of the reference security, or the
reference security is one of the following: (A) An entity reporting
under the Exchange Act, providing Securities Act Rule 144A(d)(4)
information, or about which financial information is otherwise
publicly available; (B) a foreign private issuer whose securities
are listed outside the United States and that has its principal
trading market outside the United States; (C) a foreign sovereign
debt security; (D) an asset-backed security, as defined in
Regulation AB, issued in a registered transaction with publicly
available distribution reports; or (E) an asset-backed security
issued or guaranteed by the Fannie Mae, Freddie Mac or the
Government National Mortgage Association (``Ginnie Mae''); or (ii)
the reference index is an index in which 80 percent or more of the
index's weighting is comprised of the entities or securities
described in subparagraph (i). As discussed above, the Commission's
action today does not affect CDS that are swap agreements under
Section 206A of the Gramm-Leach-Bliley Act. See text at note 10,
supra.
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Our action today balances the aim of facilitating the prompt
establishment of ICE Trust as a CCP for non-excluded CDS transactions--
which should help reduce systemic risks during a period of extreme
turmoil in the U.S. and global financial markets--with ensuring that
important elements of Commission oversight are applied to the non-
excluded CDS market. In doing so, we are mindful that applying the full
scope of the Exchange Act to transactions involving non-excluded CDS
could deter the prompt establishment of ICE Trust as a CCP to settle
those transactions.
While we are acting so that the prompt establishment of ICE Trust
as a CCP for non-excluded CDS will not be delayed by the need to apply
the full scope of Exchange Act Section 17A's requirements that govern
clearing agencies, the relief we are providing is temporary and
conditional. The limited duration of the exemptions will permit the
Commission to gain more direct experience with the non-excluded CDS
market after ICE Trust becomes operational, giving the Commission the
ability to oversee the development of the centrally cleared non-
excluded CDS market as it evolves. During the exemptive period, the
Commission will closely monitor the impact of the CCPs on the CDS
market. In particular, the Commission will seek to assure itself that
the CCPs do not act in anticompetitive manner or indirectly facilitate
anticompetitive behavior with respect to fees charged to members, the
dissemination of market data and the access to clearing services by
independent CDS exchanges or CDS trading platforms. The Commission will
take that experience into account in future actions.
Moreover, this temporary exemption in part is based on ICE Trust's
[[Page 10795]]
representation that it meets the standards set forth in the Committee
on Payment and Settlement Systems (``CPSS'') and IOSCO report entitled:
Recommendation for Central Counterparties (``RCCP'').\22\ The RCCP
establishes a framework that requires a CCP to have: (i) The ability to
facilitate the prompt and accurate clearance and settlement of CDS
transactions and to safeguard its users' assets; and (ii) sound risk
management, including the ability to appropriately determine and
collect clearing fund and monitor its users' trading. This framework is
generally consistent with the requirements of Section 17A of the
Exchange Act.
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\22\ The RCCP was drafted by a joint task force (``Task Force'')
composed of representative members of IOSCO and CPSS and published
in November 2004. The Task Force consisted of securities regulators
and central bankers from 19 countries and the European Union. The
U.S. representatives on the Task Force included staff from the
Commission, the FRB, and the CFTC.
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In addition, this Order is designed to assure that--as represented
in the request on behalf of ICE Trust--information will be available to
market participants about the terms of the CDS cleared by ICE Trust,
the creditworthiness of ICE Trust or any guarantor, and the clearing
and settlement process for the CDS. Moreover, to be within the
definition of Cleared CDS for purposes of this exemption (as well as
the other exemptions granted through this Order), a CDS may only
involve a reference entity, a reference security, an issuer of a
reference security, or a reference index that satisfies certain
conditions relating to the availability of information about such
persons or securities. For non-excluded CDS that are index-based, the
definition provides that at least 80 percent of the weighting of the
index must be comprised of reference entities, issuers of a reference
security, or reference securities that satisfy the information
conditions. The definition does not prescribe the type of financial
information that must be available nor the location of the particular
information, recognizing that eligible contract participants have
access to information about reference entities and reference securities
through multiple sources. The Commission believes, however, that it is
important in the CDS market, as in the market for securities generally,
that parties to transactions should have access to financial
information that would allow them to appropriately evaluate the risks
relating to a particular investment and make more informed investment
decisions.\23\ Such information availability also will assist ICE Trust
and the buyers and sellers in valuing their Cleared CDS and their
counterparty exposures. As a result of the Commission's actions today,
the Commission believes that information should be available for market
participants to be able to make informed investment decisions, and
value and evaluate their Cleared CDS and their counterparty exposures.
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\23\ The Commission notes the recommendations of the President's
Working Group on Financial Markets regarding the informational needs
and due diligence responsibilities of investors. See Policy
Statement on Financial Market Developments, The President's Working
Group on Financial Markets, March 13, 2008, available at: http://
www.treas.gov/press/releases/reports/pwgpolicystatemktturmoil_
03122008.pdf.
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This temporary exemption is subject to a number of conditions that
are designed to enable Commission staff to monitor ICE Trust's
clearance and settlement of CDS transactions and help reduce risk in
the CDS market. These conditions require that ICE Trust: (i) Make
available on its Web site its annual audited financial statements; (ii)
preserve records related to the conduct of its Cleared CDS clearance
and settlement services for at least five years (in an easily
accessible place for the first two years); (iii) provide information
relating to its Cleared CDS clearance and settlement services to the
Commission and provide access to the Commission to conduct on-site
inspections of facilities, records and personnel related to its Cleared
CDS clearance and settlement services; (iv) notify the Commission about
material disciplinary actions taken against any of its members
utilizing its Cleared CDS clearance and settlement services, and about
the involuntary termination of the membership of an entity that is
utilizing ICE Trust's Cleared CDS clearance and settlement services;
(v) provide the Commission with changes to rules, procedures, and any
other material events affecting its Cleared CDS clearance and
settlement services; (vi) provide the Commission with reports prepared
by independent audit personnel that are generated in accordance with
risk assessment of the areas set forth in the Commission's Automation
Review Policy Statements \24\ and its annual audited financial
statements prepared by independent audit personnel; and (vii) report
all significant systems outages to the Commission.
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\24\ See Automated Systems of Self-Regulatory Organization,
Exchange Act Release No. 27445 (November 16, 1989), File No. S7-29-
89, and Automated Systems of Self-Regulatory Organization (II),
Exchange Act Release No. 29185 (May 9, 1991), File No. S7-12-19.
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In addition, this relief is conditioned on ICE Trust, directly or
indirectly, making available to the public on terms that are fair and
reasonable and not unreasonably discriminatory: (i) All end-of-day
settlement prices and any other prices with respect to Cleared CDS that
ICE Trust may establish to calculate mark-to-market margin requirements
for ICE Trust Participants; and (ii) any other pricing or valuation
information with respect to Cleared CDS as is published or distributed
by ICE Trust. The Commission believes this is an appropriate condition
for ICE Trust's exemption from registration as a clearing agency. In
Section 11A of the Exchange Act, Congress found that ``[i]t is in the
public interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to assure * * * the
availability to brokers, dealers, and investors of information with
respect to quotations for and transactions in securities.'' \25\ The
President's Working Group on Financial Markets has stated that
increased transparency is a policy objective for the over-the-counter
derivatives market,\26\ which includes the market for CDS. The
condition is designed to further this policy objective of both Congress
and the President's Working Group by requiring ICE Trust to make useful
pricing data available to the public on terms that are fair and
reasonable and not unreasonably discriminatory. Congress adopted these
standards for the distribution of data in Section 11A. The Commission
long has applied the standards in the specific context of securities
market data,\27\ and it anticipates that ICE Trust will distribute its
data on terms that generally are consistent with the application of
these standards to securities market data. For example, data
distributors generally are required to treat subscribers equally and
not grant special access, fees, or other privileges to favored
customers of the distributor. Similarly, distributors must make their
data feeds reasonably available to data vendors for those subscribers
who wish to receive their data indirectly through a vendor rather
[[Page 10796]]
than directly from the distributor. In addition, a distributor's
attempt to tie data products that must be made available to the public
with other products or services of the distributor would be
inconsistent with the statutory requirements.\28\ The Commission
carefully evaluates any type of discrimination with respect to
subscribers and vendors to assess whether there is a reasonable basis
for the discrimination given, among other things, the Exchange Act
objective of promoting price transparency.\29\ Moreover, preventing
unreasonable discrimination is a practical means to promote fair and
reasonable terms for data distribution because distributors are more
likely to act appropriately when the terms applicable to the broader
public also must apply to any favored classes of customers.\30\
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\25\ 15 U.S.C. 78k-1(a)(1)(C)(iii). See also 15 U.S.C. 78k-
1(a)(1)(D).
\26\ See President's Working Group on Financial Markets, Policy
Objectives for the OTC Derivatives Market (November 14, 2008),
available at http://www.ustreas.gov/press/releases/reports/
policyobjectives.pdf (``Public reporting of prices, trading volumes
and aggregate open interest should be required to increase market
transparency for participants and the public.'').
\27\ See Exchange Act Release No. 42209 (December 9, 1999), 64
FR 70613, 70621-70623 (December 17, 1999) (``Market Information
Concept Release'') (discussion of legal standards applicable to
market data distribution since Section 11A was adopted in 1975).
\28\ See Exchange Act Release No. 59039 (December 2, 2008), 73
FR 74770, 74793 (December 9, 2008) (``NYSE ArcaBook Order'')
(``[S]ection 6 and Exchange Act Rule 603(a) require NYSE Arca to
distribute the ArcaBook data on terms that are not tied to other
products in a way that is unfairly discriminatory or
anticompetitive.'').
\29\ See Market Information Concept Release, 64 FR at 70630
(``The most important objectives for the Commission to consider in
evaluating fees are to assure (1) the wide availability of market
information, (2) the neutrality of fees among markets, vendors,
broker-dealers, and users, (3) the quality of market information--
its integrity, reliability, and accuracy, and (4) fair competition
and equal regulation among markets and broker-dealers.'').
\30\ See NYSE ArcaBook Order, 73 FR at 74794 (``[T]he proposed
fees for ArcaBook data will apply equally to all professional
subscribers and all non-professional subscribers * * * The fees
therefore do not unreasonably discriminate among types of
subscribers, such as by favoring participants in the NYSE Arca
market or penalizing participants in other markets.'').
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As a CCP, ICE Trust will collect and process information about CDS
transactions, prices, and positions from all of its participants. With
this information, a CCP will, among other things, calculate and
disseminate current values for open positions for the purpose of
setting appropriate margin levels. The availability of such information
can improve fairness, efficiency, and competitiveness of the market--
all of which enhance investor protection and facilitate capital
formation. Moreover, with pricing and valuation information relating to
Cleared CDS, market participants would be able to derive information
about underlying securities and indexes. This may improve the
efficiency and effectiveness of the securities markets by allowing
investors to better understand credit conditions generally.
2. Exemption From Sections 5 and 6 of the Exchange Act
ICE Trust represents that, in connection with its clearing and risk
management process, it will calculate an end-of-day settlement price
for each Cleared CDS in which an ICE Trust Participant has a cleared
position, based on prices submitted by ICE Trust Participants. As part
of this mark-to-market process, ICE Trust will periodically require ICE
Trust Participants to execute certain CDS trades at the applicable end-
of-day settlement price. Requiring ICE Trust Participants to trade CDS
periodically in this manner is designed to help ensure that such
submitted prices reflect each ICE Trust Participant's best assessment
of the value of each of its open positions in Cleared CDS on a daily
basis, thereby reducing risk by allowing ICE Trust to impose
appropriate margin requirements.
Section 5 of the Exchange Act states that ``[i]t shall be unlawful
for any broker, dealer, or exchange, directly or indirectly, to make
use of the mails or any means or instrumentality of interstate commerce
for the purpose of using any facility of an exchange * * * to effect
any transaction in a security, or to report any such transactions,
unless such exchange (1) is registered as a national securities
exchange under section 6 of [the Exchange Act], or (2) is exempted from
such registration * * * by reason of the limited volume of transactions
effected on such exchange. * * *'' \31\ Section 6 of the Exchange Act
sets forth a procedure whereby an exchange \32\ may register as a
national securities exchange.\33\ To facilitate the establishment of
ICE Trust's end-of-day settlement price process, including the
periodically required trading described above, the Commission is
exercising its authority under Section 36 of the Exchange Act to
temporarily exempt ICE Trust and ICE Trust Participants from Sections 5
and 6 of the Exchange Act and the rules and regulations thereunder in
connection with ICE Trust's calculation of mark-to-market prices for
open positions in Cleared CDS. This temporary exemption is subject to
the following conditions:
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\31\ 15 U.S.C. 78e.
\32\ Section 3(a)(1) of the Exchange Act, 15 U.S.C. 78c(a)(1),
defines ``exchange.'' Rule 3b-16 under the Exchange Act, 17 CFR
240.3b-16, defines certain terms used in the statutory definition of
exchange. See Exchange Act Release No. 40760 (December 8, 1998), 63
FR 70844 (December 22, 1998) (adopting Rule 3b-16 in addition to
Regulation ATS).
\33\ 15 U.S.C. 78f. Section 6 of the Exchange Act also sets
forth various requirements to which a national securities exchange
is subject.
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First, ICE Trust must report the following information with respect
to the calculation of mark-to-market prices for Cleared CDS to the
Commission within 30 days of the end of each quarter, and preserve such
reports during the life of the enterprise and of any successor
enterprise:
The total dollar volume of transactions executed during
the quarter, broken down by reference entity, security, or index; and
The total unit volume and/or notional amount executed
during the quarter, broken down by reference entity, security, or
index.
Reporting of this information will assist the Commission in carrying
out its responsibility to supervise and regulate the securities
markets.
Second, ICE Trust must establish adequate safeguards and procedures
to protect participants' confidential trading information. Such
safeguards and procedures shall include: (a) Limiting access to the
confidential trading information of participants to those employees of
ICE Trust who are operating the system or responsible for its
compliance with this exemption or any other applicable rules; and (b)
implementing standards controlling employees of ICE Trust trading for
their own accounts. ICE Trust must adopt and implement adequate
oversight procedures to ensure that the safeguards and procedures
established pursuant to this condition are followed. This condition is
designed to prevent any misuse of ICE Trust Participant trading
information that may be available to ICE Trust in connection with the
daily marking-to-market process of open positions in Cleared CDS. This
should strengthen confidence in ICE Trust as a CCP for CDS, promoting
participation.
Third, ICE Trust must comply with the conditions to the temporary
exemption from registration as a clearing agency granted in this Order.
As set forth above, this Order is designed to facilitate the prompt
establishment of ICE Trust as a CCP for non-excluded CDS. ICE Trust has
represented that, to enhance the reliability of end-of-day settlement
prices submitted as part of the daily mark-to-market process, it must
require periodic trading of Cleared CDS positions by ICE Participants
whose submitted end-of-day prices lock or cross. The Commission's
temporary exemption from Sections 5 and 6 of the Exchange Act is based
on ICE Trust's representation that the end-of-day settlement pricing
process, including the periodically required trading is integral to its
risk management.
[[Page 10797]]
Accordingly, as a condition to ICE Trust's temporary exemption from
Sections 5 and 6 of the Exchange Act, ICE trust must comply with the
conditions to the temporary exemption from Section 17A of the Exchange
Act in this Order.
The Commission is also exempting each ICE Trust Participant from
the prohibition in Section 5 of the Exchange Act to the extent that
such ICE Trust Participant uses any facility of ICE Trust to effect any
transaction in Cleared CDS, or to report any such transaction, in
connection with ICE Trust's calculation of mark-to-market prices for
open positions in Cleared CDS. Absent an exemption, Section 5 would
prohibit any ICE Trust Participant that is a broker or dealer from
effecting transactions in Cleared CDS on ICE Trust, which will rely on
this order for an exemption from exchange registration. The Commission
believes that exempting ICE Trust Participants from the restriction in
Section 5 is necessary and appropriate in the public interest and is
consistent with the protection of investors because it will facilitate
their use of ICE Trust's CCP for Cleared CDS, which for the reasons
noted in this Order the Commission believes to be beneficial. Without
also exempting ICE Trust Participants from this Section 5 requirement,
the Commission's temporary exemption of ICE Trust from Sections 5 and 6
of the Exchange Act would be ineffective, because ICE Trust
Participants that are brokers or dealers would not be permitted to
effect transactions on ICE Trust in connection with the end-of-day
settlement price process.
C. Temporary General Exemption for ICE Trust, Certain ICE Trust
Participants, and Certain Eligible Contract Participants
Applying the full panoply of Exchange Act requirements to
participants in transactions in non-excluded CDS likely would deter
some participants from using CCPs to clear CDS transactions. At the
same time, it is important that the antifraud provisions of the
Exchange Act apply to transactions in non-excluded CDS; indeed, OTC
transactions subject to individual negotiation that qualify as
security-based swap agreements already are subject to these antifraud
provisions.\34\
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\34\ While Section 3A of the Exchange Act excludes ``swap
agreements'' from the definition of ``security,'' certain antifraud
and insider trading provisions under the Exchange Act explicitly
apply to security-based swap agreements. See (a) paragraphs (2)
through (5) of Section 9(a), 15 U.S.C. 78i(a), prohibiting the
manipulation of security prices; (b) Section 10(b), 15 U.S.C.
78j(b), and underlying rules prohibiting fraud, manipulation or
insider trading (but not prophylactic reporting or recordkeeping
requirements); (c) Section 15(c)(1), 15 U.S.C. 78o(c)(1), which
prohibits brokers and dealers from using manipulative or deceptive
devices; (d) Sections 16(a) and (b), 15 U.S.C. 78p(a) and (b), which
address disclosure by directors, officers and principal
stockholders, and short-swing trading by those persons, and rules
with respect to reporting requirements under Section 16(a); (e)
Section 20(d), 15 U.S.C. 78t(d), providing for antifraud liability
in connection with certain derivative transactions; and (f) Section
21A(a)(1), 15 U.S.C. 78u-1(a)(1), related to the Commission's
authority to impose civil penalties for insider trading violations.
``Security-based swap agreement'' is defined in Section 206B of
the Gramm-Leach-Bliley Act as a swap agreement in which a material
term is based on the price, yield, value, or volatility of any
security or any group or index of securities, or any interest
therein.
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We thus believe that it is appropriate in the public interest and
consistent with the protection of investors temporarily to apply
substantially the same framework to transactions by market participants
in non-excluded CDS that applies to transactions in security-based swap
agreements. Applying substantially the same set of requirements to
participants in transactions in non-excluded CDS as apply to
participants in OTC CDS transactions will avoid deterring market
participants from promptly using CCPs, which would detract from the
potential benefits of central clearing.
Accordingly, pursuant to Section 36 of the Exchange Act, the
Commission finds that it is necessary or appropriate in the public
interest and is consistent with the protection of investors to exercise
its authority to grant an exemption until December 7, 2009 from certain
requirements under the Exchange Act. This temporary exemption applies
to ICE Trust, any ICE Trust Participant \35\ which is not a broker or
dealer registered under Section 15(b) of the Exchange Act (other than
paragraph (11) thereof), and any eligible contract participants \36\
other than: Eligible contract participants that receive or hold funds
or securities for the purpose of purchasing, selling, clearing,
settling or holding Cleared CDS positions for other persons; \37\
eligible contract participants that are self-regulatory organizations;
or eligible contract participants that are registered brokers or
dealers.\38\
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\35\ For purposes of this Order, an ``ICE Trust Participant''
means any participant in ICE Trust that submits Cleared CDS to ICE
Trust for clearance and settlement exclusively (i) for its own
account or (ii) for the account of an affiliate that controls, is
controlled by, or is under common control with the participant in
ICE Trust. In general, this exemption does not apply to any ICE
Trust Participant that is registered with the Commission as a
broker-dealer. A separate temporary exemption addresses the Cleared
CDS activities of registered broker-dealers. See Part II.D., infra.
\36\ This exemption in general applies to eligible contract
participants, as defined in Section 1a(12) of the Commodity Exchange
Act as in effect on the date of this Order, other than persons that
are eligible contract participants under paragraph (C) of that
section.
\37\ For these purposes, and for the purpose of the definition
of ``Cleared CDS,'' the terms ``purchasing'' and ``selling'' mean
the execution, termination (prior to its scheduled maturity date),
assignment, exchange, or similar transfer or conveyance of, or
extinguishing the rights or obligations under, a Cleared CDS, as the
context may require. This is consistent with the meaning of the
terms ``purchase'' or ``sale'' under the Exchange Act in the context
of security-based swap agreements. See Exchange Act Section
3A(b)(4).
\38\ A separate temporary exemption addresses the Cleared CDS
activities of registered broker-dealers. See Part II.D., infra..
Solely for purposes of this Order, a registered broker-dealer, or a
broker or dealer registered under Section 15(b) of the Exchange Act,
does not refer to someone that would otherwise be required to
register as a broker or dealer solely as a result of activities in
Cleared CDS in compliance with this Order.
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Under this temporary exemption, and solely with respect to Cleared
CDS, these persons generally are exempt from provisions of the Exchange
Act and the rules and regulations thereunder that do not apply to
security-based swap agreements. Those persons thus would still be
subject to those Exchange Act requirements that explicitly are
applicable in connection with security-based swap agreements.\39\ In
addition, all provisions of the Exchange Act related to the
Commission's enforcement authority in connection with violations or
potential violations of such provisions would remain applicable.\40\ In
this way, the temporary exemption would apply the same Exchange Act
requirements in connection with non-excluded CDS as apply in connection
with OTC credit default swaps.
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\39\ See note 34, supra.
\40\ Thus, for example, the Commission retains the ability to
investigate potential violations and bring enforcement actions in
the Federal courts and administrative proceedings, and to seek the
full panoply of remedies available in such cases.
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This temporary exemption, however, does not extend to Sections 5
and 6 of the Exchange Act.\41\ The Commission separately issued a
conditional exemption from these provisions to all broker-dealers and
exchanges.\42\ This
[[Page 10798]]
temporary exemption also does not extend to Section 17A of the Exchange
Act; instead, ICE Trust is exempt from registration as a clearing
agency under the conditions discussed above. In addition, this
exemption does not apply to Exchange Act Sections 12, 13, 14, 15(d),
and 16; \43\ eligible contract participants and other persons instead
should refer to the interim final temporary rules issued by the
Commission. Finally, this temporary exemption does not extend to the
Commission's administrative proceeding authority under Sections
15(b)(4) and (b)(6),\44\ or to certain provisions related to government
securities.\45\
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\41\ This Order includes a separate temporary exemption
regarding the mark-to-market process of ICE Trust, discussed above.
\42\ See note 17, supra. A national securities exchange that
effects transactions in Cleared CDS would continue to be required to
comply with all requirements under the Exchange Act applicable to
such transactions. A national securities exchange could form
subsidiaries or affiliates that operate exchanges exempt under that
order. Any subsidiary or affiliate of a registered exchange could
not integrate, or otherwise link, the exempt CDS exchange with the
registered exchange including the premises or property of such
exchange for effecting or reporting a transaction without being
considered a ``facility of the exchange.'' See Section 3(a)(2), 15
U.S.C. 78c(a)(2).
\43\ 15 U.S.C. 78l, 78m, 78n, 78o(d), 78p.
\44\ Exchange Act Sections 15(b)(4) and 15(b)(6), 15 U.S.C.
78o(b)(4) and (b)(6), grant the Commission authority to take action
against broker-dealers and associated persons in certain situations.
Accordingly, while this exemption generally extends to persons that
act as inter-dealer brokers in the market for Cleared CDS and do not
hold funds or securities for others, such inter-dealer brokers may
be subject to actions under Sections 15(b)(4) and (b)(6) of the
Exchange Act.
In addition, such inter-dealer brokers may be subject to actions
under Exchange Act Section 15(c)(1), 15 U.S.C. 78o(c)(1), which
prohibits brokers and dealers from using manipulative or deceptive
devices. As noted above, Section 15(c)(1) explicitly applies to
security-based swap agreements. Sections 15(b)(4), 15(b)(6) and
15(c)(1), of course, would not apply to persons subject to this
exemption who do not act as broker-dealers or associated persons of
broker-dealers.
\45\ This exemption specifically does not extend to the Exchange
Act provisions applicable to government securities, as set forth in
Section 15C, 15 U.S.C. 78o-5, and its underlying rules and
regulations; nor does the exemption extend to related definitions
found at paragraphs (42) through (45) of Section 3(a), 15 U.S.C.
78c(a). The Commission does not have authority under Section 36 to
issue exemptions in connection with those provisions. See Exchange
Act Section 36(b), 15 U.S.C. 78mm(b).
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D. Temporary General Exemption for Certain Registered Broker-Dealers
The temporary exemptions addressed above--with regard to ICE Trust,
certain ICE Trust Participants, and certain eligible contract
participants--are not available to persons that are registered as
broker-dealers with the Commission (other than those that are notice
registered pursuant to Section 15(b)(11)).\46\ The Exchange Act and its
underlying rules and regulations require broker-dealers to comply with
a number of obligations that are important to protecting investors and
promoting market integrity. We are mindful of the need to avoid
creating disincentives to the prompt use of CCPs, and we recognize that
the factors discussed above suggest that the full panoply of Exchange
Act requirements should not immediately be applied to registered
broker-dealers that engage in transactions involving Cleared CDS. At
the same time, we also are sensitive to the critical importance of
certain broker-dealer requirements to promoting market integrity and
protecting customers (including those broker-dealer customers that are
not involved with CDS transactions).
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\46\ Exchange Act Section 15(b)(11) provides for notice
registration of certain persons that effect transactions in security
futures products. 15 U.S.C. 78o(b)(11).
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This calls for balancing the facilitation of the development and
prompt implementation of CCPs with the preservation of certain key
investor protections. Pursuant to Section 36 of the Exchange Act, the
Commission finds that it is necessary or appropriate in the public
interest and is consistent with the protection of investors to exercise
its authority to grant an exemption until December 7, 2009 from certain
Exchange Act requirements. Consistent with the temporary exemptions
discussed above, and solely with respect to Cleared CDS, we are
exempting registered broker-dealers in general from provisions of the
Exchange Act and its underlying rules and regulations that do not apply
to security-based swap agreements. As above, we are not excluding
registered broker-dealers from Exchange Act provisions that explicitly
apply in connection with security-based swap agreements or from related
enforcement authority provisions.\47\ As above, and for similar
reasons, we are not exempting registered broker-dealers from: Sections
5, 6, 12(a) and (g), 13, 14, 15(b)(4), 15(b)(6), 15(d), 16 and 17A of
the Exchange Act.\48\
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\47\ See notes 34 and 40, supra. As noted above, broker-dealers
also would be subject to Section 15(c)(1) of the Exchange Act, which
prohibits brokers and dealers from using manipulative or deceptive
devices, because that provision explicitly applies in connection
with security-based swap agreements. In addition, to the extent the
Exchange Act and any rule or regulation thereunder imposes any other
requirement on a broker-dealer with respect to security-based swap
agreements (e.g., requirements under Rule 17h-1T to maintain and
preserve written policies, procedures, or systems concerning the
broker or dealer's trading positions and risks, such as policies
relating to restrictions or limitations on trading financial
instruments or products), these requirements would continue to apply
to broker-dealers' activities with respect to Cleared CDS.
\48\ We also are not exempting those members from provisions
related to government securities, as discussed above.
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Further we are not exempting registered broker-dealers from the
following additional provisions under the Exchange Act: (1) Section
7(c),\49\ which addresses the unlawful extension of credit by broker-
dealers; (2) Section 15(c)(3),\50\ which addresses the use of unlawful
or manipulative devices by broker-dealers; (3) Section 17(a),\51\
regarding broker-dealer obligations to make, keep and furnish
information; (4) Section 17(b),\52\ regarding broker-dealer records
subject to examination; (5) Regulation T,\53\ a Federal Reserve Board
regulation regarding extension of credit by broker-dealers; (6)
Exchange Act Rule 15c3-1, regarding broker-dealer net capital; (7)
Exchange Act Rule 15c3-3, regarding broker-dealer reserves and custody
of securities; (8) Exchange Act Rules 17a-3 through 17a-5, regarding
records to be made and preserved by broker-dealers and reports to be
made by broker-dealers; and (9) Exchange Act Rule 17a-13, regarding
quarterly security counts to be made by certain exchange members and
broker-dealers.\54\ Registered broker-dealers should comply with these
provisions in connection with their activities involving non-excluded
CDS because these provisions are especially important to helping
protect customer funds and securities, ensure proper credit practices
and safeguard against fraud and abuse.\55\
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\49\ 15 U.S.C. 78g(c).
\50\ 15 U.S.C. 78o(c)(3).
\51\ 15 U.S.C. 78q(a).
\52\ 15 U.S.C. 78q(b).
\53\ 12 CFR 220.1 et seq.
\54\ Solely for purposes of this exemption, in addition to the
general requirements under the referenced Exchange Act sections,
registered broker-dealers shall only be subject to the enumerated
rules under the referenced Exchange Act sections.
\55\ Indeed, Congress directed the Commission to promulgate
broker-dealer financial responsibility rules, including rules
regarding custody, the use of customer securities and the use of
customers' deposits or credit balances, and regarding establishment
of minimum financial requirements.
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E. Solicitation of Comments
The Commission intends to monitor closely the development of the
CDS market and intends to determine to what extent, if any, additional
regulatory action may be necessary. For example, as circumstances
warrant, certain conditions could be added, altered, or eliminated.
Moreover, because these exemptions are temporary, the Commission will
in the future consider whether they should be extended or allowed to
expire. The Commission believes it would be prudent to solicit public
comment on its action today, and on what action it should take with
respect to the CDS market in the future. The Commission is soliciting
public comment on all aspects of these exemptions, including:
1. Whether the length of this temporary exemption (until December
7, 2009) is appropriate. If not, what should the appropriate duration
be?
[[Page 10799]]
2. Whether the conditions to these exemptions are appropriate. Why
or why not? Should other conditions apply? Are any of the present
conditions to the exemptions provided in this Order unnecessary? If so,
please specify and explain why such conditions are not needed.
3. Whether ICE Trust ultimately should be required to register as a
clearing agency under the Exchange Act. Why or why not?
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://
www.sec.gov/rules/other.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-05-09 on the subject line; or
Use the Federal eRulemaking Portal (http://
www.regulations.gov/). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.
All submissions should refer to File Number S7-05-09. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. We will post all comments on the Commission's Internet Web site
(http://www.sec.gov/rules/other.shtml). Comments are also available for
public inspection and copying in the Commission's Public Reference
Room, 100 F Street, NE., Washington, DC 20549, on official business
days between the hours of 10 a.m. and 3 p.m. All comments received will
be posted without change; we do not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly.
III. Conclusion
It is hereby ordered, pursuant to Section 36(a) of the Exchange
Act, that, until December 7, 2009:
(a) Exemption From Section 17A of the Exchange Act
ICE US Trust LLC (``ICE Trust'') shall be exempt from Section 17A
of the Exchange Act solely to perform the functions of a clearing
agency for Cleared CDS (as defined in paragraph (e)(1) of this Order),
subject to the following conditions:
(1) ICE Trust shall make available on its Web site its annual
audited financial statements.
(2) ICE Trust shall keep and preserve at least one copy of all
documents, including all correspondence, memoranda, papers, books,
notices, accounts, and other such records as shall be made or received
by it relating to its Cleared CDS clearance and settlement services.
These records shall be kept for at least five years and for the first
two years shall be held in an easily accessible place.
(3) ICE Trust shall supply information and periodic reports
relating to its Cleared CDS clearance and settlement services as may be
reasonably requested by the Commission, and shall provide access to the
Commission to conduct on-site inspections of all facilities (including
automated systems and systems environment), records, and personnel
related to ICE Trust's Cleared CDS clearance and settlement services.
(4) ICE Trust shall notify the Commission, on a monthly basis, of
any material disciplinary actions taken against any of its members
utilizing its Cleared CDS clearance and settlement services, including
the denial of services, fines, or penalties. ICE Trust shall notify the
Commission promptly when ICE Trust involuntarily terminates the
membership of an entity that is utilizing ICE Trust's Cleared CDS
clearance and settlement services. Both notifications shall describe
the facts and circumstances that led to the ICE Trust's disciplinary
action.
(5) ICE Trust notify the Commission of all changes to rules,
procedures, and any other material events affecting its Cleared CDS
clearance and settlement services, including its fee schedule and
changes to risk management practices, the day before effectiveness or
implementation of such rule changes or, in exigent circumstances, as
promptly as reasonably practicable under the circumstances. All such
rule changes will be posted on ICE Trust's Web site. Such notifications
will not be deemed rule filings that require Commission approval.
(6) ICE Trust shall provide the Commission with reports prepared by
independent audit personnel that are generated in accordance with risk
assessment of the areas set forth in the Commission's Automation Review
Policy Statements. ICE Trust shall provide the Commission with
(beginning in its first year of operation) its annual audited financial
statements prepared by independent audit personnel.
(7) ICE Trust shall report all significant systems outages to the
Commission. If it appears that the outage may extend for 30 minutes or
longer, ICE Trust shall report the systems outage immediately. If it
appears that the outage will be resolved in less than 30 minutes, ICE
Trust shall report the systems outage within a reasonable time after
the outage has been resolved.
(8) ICE Trust, directly or indirectly, shall make available to the
public on terms that are fair and reasonable and not unreasonably
discriminatory: (i) all end-of-day settlement prices and any other
prices with respect to Cleared CDS that ICE Trust may establish to
calculate mark-to-market margin requirements for ICE Trust
Participants; and (ii) any other pricing or valuation information with
respect to Cleared CDS as is published or distributed by ICE Trust.
(b) Exemption From Sections 5 and 6 of the Exchange Act
(1) ICE Trust shall be exempt from the requirements of Sections 5
and 6 of the Exchange Act and the rules and regulations thereunder in
connection with its calculation of mark-to-market prices for open
positions in Cleared CDS, subject to the following conditions:
(i) ICE Trust shall report the following information with respect
to the calculation of mark-to-market prices for Cleared CDS to the
Commission within 30 days of the end of each quarter, and preserve such
reports during the life of the enterprise and of any successor
enterprise:
(A) The total dollar volume of transactions executed during the
quarter, broken down by reference entity, security, or index; and
(B) The total unit volume and/or notional amount executed during
the quarter, broken down by reference entity, security, or index;
(ii) ICE Trust shall establish adequate safeguards and procedures
to protect participants' confidential trading information. Such
safeguards and procedures shall include: (A) Limiting access to the
confidential trading information of participants to those employees of
ICE Trust who are operating the system or responsible for its
compliance with this exemption or any other applicable rules; and (B)
implementing standards controlling employees of ICE Trust trading for
their own accounts. ICE Trust must adopt and implement adequate
oversight procedures to ensure that the safeguards and procedures
established pursuant to this condition are followed; and
(iii) ICE Trust shall satisfy the conditions of the temporary
exemption from Section 17A of the Exchange Act
[[Page 10800]]
set forth in paragraphs (a)(1)-(8) of this Order.
(2) Any ICE Trust Participant shall be exempt from the requirements
of Section 5 of the Exchange Act to the extent such ICE Trust
Participant uses any facility of ICE Trust to effect any transaction in
Cleared CDS, or to report any such transaction, in connection with ICE
Trust's clearance and risk management process for Cleared CDS.
(c) Exemption for ICE Trust, Certain ICE Trust Participants, and
Certain Eligible Contract Participants
(1) Persons eligible. The exemption in paragraph (c)(2) is
available to:
(i) ICE Trust;
(ii) Any ICE Trust Participant (as defined in paragraph (e)(2) of
this Order), which is not a broker or dealer registered under Section
15(b) of the Exchange Act (other than paragraph (11) thereof); and
(iii) Any eligible contract participant (as defined in Section
1a(12) of the Commodity Exchange Act as in effect on the date of this
Order (other than a person that is an eligible contract participant
under paragraph (C) of that section)), other than: (A) an eligible
contract participant that receives or holds funds or securities for the
purpose of purchasing, selling, clearing, settling, or holding Cleared
CDS positions for other persons; (B) an eligible contract participant
that is a self-regulatory organization, as that term is defined in
Section 3(a)(26) of the Exchange Act; or (C) a broker or dealer
registered under Section 15(b) of the Exchange Act (other than
paragraph (11) thereof).
(2) Scope of exemption.
(i) In general. Such persons generally shall, solely with respect
to Cleared CDS, be exempt from the provisions of the Exchange Act and
the rules and regulations thereunder that do not apply in connection
with security-based swap agreements. Accordingly, under this exemption,
those persons would remain subject to those Exchange Act requirements
that explicitly are applicable in connection with security-based swap
agreements (i.e., paragraphs (2) through (5) of Section 9(a), Section
10(b), Section 15(c)(1), paragraphs (a) and (b) of Section 16, Section
20(d) and Section 21A(a)(1) and the rules thereunder that explicitly
are applicable to security-based swap agreements). All provisions of
the Exchange Act related to the Commission's enforcement authority in
connection with violations or potential violations of such provisions
also remain applicable.
(ii) Exclusions from exemption. The exemption in paragraph
(c)(2)(i), however, does not extend to the following provisions under
the Exchange Act:
(A) Paragraphs (42), (43), (44), and (45) of Section 3(a);
(B) Section 5;
(C) Section 6;
(D) Section 12 and the rules and regulations thereunder;
(E) Section 13 and the rules and regulations thereunder;
(F) Section 14 and the rules and regulations thereunder;
(G) Paragraphs (4) and (6) of Section 15(b);
(H) Section 15(d) and the rules and regulations thereunder;
(I) Section 15C and the rules and regulations thereunder;
(J) Section 16 and the rules and regulations thereunder; and
(K) Section 17A (other than as provided in paragraph (a)).
(d) Exemption for Certain Registered Broker-Dealers
A broker or dealer registered under Section 15(b) of the Exchange
Act (other than paragraph (11) thereof) shall be exempt from the
provisions of the Exchange Act and the rules and regulations thereunder
specified in paragraph (c)(2), solely with respect to Cleared CDS,
except:
(1) Section 7(c);
(2) Section 15(c)(3);
(3) Section 17(a);
(4) Section 17(b);
(5) Regulation T, 12 CFR 200.1 et seq.;
(6) Rule 15c3-1;
(7) Rule 15c3-3;
(8) Rule 17a-3;
(9) Rule 17a-4;
(10) Rule 17a-5; and
(11) Rule 17a-13.
(e) Definitions
For purposes of this Order:
(1) ``Cleared CDS'' shall mean a credit default swap that is
submitted (or offered, purchased, or sold on terms providing for
submission) to ICE Trust, that is offered only to, purchased only by,
and sold only to eligible contract participants (as defined in Section
1a(12) of the Commodity Exchange Act as in effect on the date of this
Order (other than a person that is an eligible contract participant
under paragraph (C) of that section)), and in which:
(i) The reference entity, the issuer of the reference security, or
the reference security is one of the following:
(A) An entity reporting under the Exchange Act, providing
Securities Act Rule 144A(d)(4) information, or about which financial
information is otherwise publicly available;
(B) a foreign private issuer whose securities are listed outside
the United States and that has its principal trading market outside the
United States;
(C) a foreign sovereign debt security;
(D) an asset-backed security, as defined in Regulation AB, issued
in a registered transaction with publicly available distribution
reports; or
(E) an asset-backed security issued or guaranteed by Fannie Mae,
Freddie Mac or Ginnie Mae; or
(ii) the reference index is an index in which 80 percent or more of
the index's weighting is comprised of the entities or securities
described in subparagraph (i).
(2) ``ICE Trust Participant'' shall mean any participant in ICE
Trust that submits Cleared CDS to ICE Trust for clearance and
settlement exclusively (i) for its own account or (ii) for the account
of an affiliate that controls, is controlled by, or is under common
control with the participant in ICE Trust.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-5299 Filed 3-11-09; 8:45 am]
BILLING CODE 8011-01-P
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